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A quick guide to understanding credit reports

Julian Winfield, UK chief executive of financial services provider Hoist Finance, explores the European market for non-performing loans (NPLs) and its growth prospects for 2020.

Non-performing loans are an essential part of the lending business, and the likelihood of non-repayment is an inherent risk. Risk of loss is part of the credit rating vehicle title loans in GA banks assign to borrowers and is, therefore, included in the cost of borrowing. Loan losses and NPLs generally encompass non-performing loans, insolvency proceedings and debts where customers’ payments fail to meet the contractual terms.

The probability that a loan will be repaid in full is substantially lower once the loan has been classified as non-performing. As a result, debt purchasing organisations, such as Hoist Finance, can acquire NPL portfolios at a significant discount to the loans’ nominal total value.

Perhaps not surprisingly, the banks themselves (i.e. the ‘sellers’) often have a different view of the value of their loans, which has hampered NPL divestments. Slow procedures and structural inefficiencies in debt recovery have been instrumental in limiting the transaction market.

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In the growth markets, which include Spain and Poland, the picture is rather more encouraging. There is a healthy competition among NPL purchasers and decreasing bid-ask spreads. Local banks are gradually becoming more active, portfolios are more ‘current’ and the quality of NPLs being sold is of a generally higher standard.

In the most mature markets, such as the UK and Germany, NPL sales are an integral part of the financial ecosystem. Two particular trends are evident: firstly, the quality of the NPLs portfolios being sold; and secondly, the trend towards increased consolidation resulting in a fewer number of larger debt purchasers.

Price increases

Competition for loan portfolios is a contributing factor to the price increase, which puts pressure on ent has been driven over the past five or six years by lower borrowing costs, which appear to have bottomed out in 2018 and are on the way up again.

While prices ount NPLs are decreasing. In Europe, the volume of outstanding NPLs in the banking sector decreased to approximately SEK 7,143bn (?580bn) as per Q3 2018, compared to approximately SEK 10,000bn in 2017. This amount represents around 3.4% of all loans, compared with 5% in 2017. The decrease, while gradual, is partly due to legislation facilitating trade in receivables aimed at reducing the number of receivables in the European banking system.

There are a number of trends that affect ent and that the debt purchasers are now planning for. These include: the impact of strong market growth; the demand for increased operational efficiency that is in turn driving industry consolidation; increasing funding costs; and continued regulation of the market and greater market maturity.

It is crucial to reduce the number of non-performing loans in Europe’s financial system. Household and SME over-indebtedness causes banks to restrict their lending, and small businesses are unable to invest; this inhibits economic growth. The transaction market is nevertheless growing, due partly to the fact that the market continues to develop and become more sophisticated.

New regulations

Another factor to consider in exploring the future market is the impact of new legislation. The introduction of IFRS 9 as from 2018, for example, requires banks to calculate and make provisions for expected credit losses as early as initial recognition following the granting of new loans. The new rules have had some positive effects, in that banks are required to report their expected credit losses at an earlier stage. The purpose of the new accounting standard for classification and measurement of financial assets is to enable earlier prediction of credit losses. Additional regulations in this area are to be expected in coming years.

A few well-respected companies have emerged as the European market matures, and Hoist Finance holds a strong position as a partner to international banks and financial institutions. The company is among the five largest in Europe measured by ERC (Estimated Remaining Collections). Efficiency and cost savings are high on the agenda for these companies and help fuel the consolidation trend, and the degree of consolidation is likely to remain greater in those mature markets with lower prices.

Market consolidation is taking place in parallel with an increase in regulation. Several major and minor transactions have been conducted in recent years, and this trend is expected to continue.